Whether you're subscribed to Netflix (NFLX, Financial), Amazon (AMZN, Financial) Prime, Peloton (PTON, Financial) or even Starbucks (SBUX, Financial), the “subscription economy” is all around us. Subscription business models are ideal as they promote repeat customer purchases, involve the customer in the ecosystem and allow cash flows to be monitored easily. For software-as-a-service (SaaS) business models, they offer higher operating leverage, which means if the number of users double usually the costs only rise by a small amount.
Thus, it’s no surprise that according to data from UBS Wealth Management, the digital subscription economy is worth $650 billion and is set to grow at a meteoric 18% growth rate between now and 2025, reaching a market size of $1.5 trillion.
What does Zuora do?
Zuora Inc. (ZUO, Financial) is a cloud-based software platform which enables the subscription service model to be implemented for the customers of a business. The firm's major customers include Siemens (XTER:SIE, Financial), Nvidia (NVDA, Financial), Zoom (ZM, Financial) and DocuSign (DOCU, Financial). The beauty of subscription models is they tend to be “sticky,” meaning customers are less likely to cancel. As Zuora is a an enabler of this business model, for subscription providers their net dollar retention rate is 110%. This means customers are staying with the firm and spending more.
Source: Zuora investor presentation
Growing financials
The firm's fundamentals are growing strong. Total revenue was $347 million for the most recent fiscal year 2022, which was an increase of 14% year over year. Full-year subscription revenue growth accelerated 19% to $287 million. However, the firm reported a GAAP loss from operations of $96.2 million, compared to a GAAP loss from operations of $73.9 million in fiscal year 2021. The good news is the firm turned full-year free cash flow positive for the first time, and without the $83 million investment into R&D, they would be able to be positive on their operating profit.
In terms of funding, Zuora received a strategic investment from the global technology investment firm Silver Lake in the amount of $400 million.
Is the stock undervalued?
In order to value Zuora's stock, I have plugged the latest financials into my discounted cash flow model. I have estimated revenues to grow 15% per year for the next five years and margins to increase to 23% in four years.
Given these assumptions I get a fair value estimate of $10 per share. The stock is currently trading at $14 per share and is thus 31% overvalued.
However, the GuruFocus Value chart rates the stock as modestly undervalued. This unique intrinsic value estimate from GuruFocus combines historical multiples, historical returns and analysts' estimates of future business performance.
Strong founder
The founder of the company, Tien Tzuo, wrote a book on the subscription economy called “Subscribed." Tzuo is a former Salesforce (CRM, Financial) executive and still owns approximately 10% of his shares in the firm. A successful investment strategy pioneered by former hedge fund manager Nick Sleep is to invest into founder-led companies where top managers have “skin in the game."
Insider selling
There are a few risks with this company. One troubling thing I did notice is lots of insider selling by the whole leadership team. Sales were occurring from $16 per share by the chief revenue officer to even $10 per share by the cheif financial officer. This is not a great sign as I would rather see the team having more faith in the firm's prospects. There are no notable insider buys in sight for the past couple of years.
Other risks include competition, as many firms can and have successfully created their own subscription services without Zuora. In addition, acquiring new enterprise customers requires a longer sales cycle.
Baillie Gifford (Trades, Portfolio) is buying
Baillie Gifford (Trades, Portfolio) is a legendary growth stock investing firm which I think of as the U.K. version of Catherine Wood (Trades, Portfolio)s' Ark invest. They were one of the original Tesla (TSLA) investors and saw tremendous gains. The firm has been adding to their Zuora position in the most recent quarter, during which shares traded for an average price of $20. The stock is down 27% from that level at the time of writing.
Final thoughts
Zuora is a fantastic company and was a true pioneer in the subscription economy. Their growth has been consistent and their founder is experienced. However, according to my DCF model, the stock is 31% overvalued. In addition, the insider selling doesn’t entice me to buy the stock right now, and thus I will just be adding it to my watch list.
